bbvista pp economic and industry analysis

8/10/2019 Bbvista Pp Economic and Industry Analysis

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Economic Analysis


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Economic Analysis

Fundamental Analysis

Approach to Fundamental AnalysisDomestic and global economic

analysis

Industry analysis

Company analysis


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Global Economic Considerations

Variability of performance in countries and regions.

Political risk

Exchange rate risk

Sales

Profits Stock returns


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Top down approach

Calls for analysis of the economy

identifying industries and companies that willperform well in that economic environment.

begins with an examination of global economicprospects.

political risk

exchange rate risk.


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Liquidity

Provided by savers and used by investors

Measured in the economy by monetary aggregates

Determined to a great extent by the central bank

Credit crisis has demonstrated that liquiditydeclines when:

investors and savers become risk averse.


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Shadow banking

Hedge funds

Investment Banks

Structured Investments ( SIV)

When:

Risk Aversion withdraws from Liquidity

shadow banks


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Interbank Borrowing Rate

Set by the FED to ensure economic growthwhile curtailing inflation (difficult balancing act)

Fed varies the FFR with risk aversion

As risk aversion Interest rates

The Feds Fund Rate


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Adjustable rate Subprime Mortgages

2004 - 2006 2/28 adjustable most popular

Buyer has no equity stake in the property

Teaser Rate first 2-years

Margin of 5% or more

Some loans were negative amortization.


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Financial Instability Hypothesis

Stable Economic Times -Investors take riskbecause they anticipate continued stability.

Behavior leads to future instability:

3-stages of economic progress


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3-stages of Economic Progress

1. Hedge Stage:

Investors have $ from income to invest

Invest safely - purchasing a home.


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2. Speculative Stage:

Riskier behavior

Interest only borrowing with balloon payments.

Investors expect:

Continued economic growth

Asset values not to decline

Interest rates to remain stable


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3. Ponzi - Unit:

Speculation phase

Investors expect property values to continuerising.

Negative amortization loans


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Key Economic Variables

Gross domestic product

Unemployment rates

interest rates & inflation

Budget Deficits

Consumer sentiment


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Demand and supply shock

Demand shock An event that affects demand for goods and services.

A tax cut

Supply shock

An event that influences production capacity or

production costs. Higher levels of education productivity production

costs (perhaps).


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Government influencesFiscal Policy- government spending and taxing actions

Stimulating the economy through Gov spending

Slowly implemented

Gov purchasing multiplier 1:1

Taxes Demand

Taxes Demand but because of savings byless than 1:1


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US Total Debt

Source: National Debt: CNBC Explains,Wednesday, 29 Jun 2011


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Limitations of fiscal policy

Recognition delay

Administrative delay

Impact delay


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Monetary Policy-

manipulation of the money supply to influence

economic activity (FFR)

Tools of monetary policy

Open market operations( federal funds rate)

Discount rate

Reserve requirements


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Inflation

Persistent P on most goods and services

Demand- pull inflation

results from MS , Gov , Consumer

GDP above full employment GDP

Will persist until Fed tightens money


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Cost - Push Inflation:

Results from increase in resource prices (wages,energy, commodities, etc.)

Initially decreases GDP

If MS D P if input P Inflation

(1970 oil crisis)


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Unanticipated Inflation:

Unexpected decrease in future purchasing power.

Redistribution of income between borrowers and lenders

Long term contract such as 30-year fixed mortgagesdecrease in value, good for consumer with fixed mortgages,hurts banks (2008-2009 liquidity crisis)

Value of wages decrease hurts employers, employees willdemand higher wages.


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Unanticipated Decrease in Inflation:

Banks win, consumers lose.

Employers win (value of wages increase),

Employees lose.


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Anticipated Inflation:

Price levels rise but the economy operated at potentialGDP

Money is a poor store of value. (2002-2005)

Taxes have a negative impact on economic output,because it distorts returns.


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Tax impact on investors ROI

Return Inflationrate ( )

Returnafter

Tax rate Real ROI

after Tax

9% 3% 6% 30% 3.3%

5% 3% 2% 30% 0.5%

2% 3% -1% 30% -1.6%

Note: Taxes are paid on the gross return (9%, 5%, 2%)


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low after tax returns reduce savings

i.r boost savings

i.r lower business investment LowerGDP

MS inflation Output (higher wages)GDP Unemployment


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Strong Currency

Little inflation

Weak Currency

High inflation


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Industry Analysis

Industry analysis helps investors isolate

investment opportunities that have

favorable risk-return characteristics.

Auto analyst, drug analyst, retail

analystetc.


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Investors look for:

Differences in industry risk

Industry performance over time

How economic trends impact differentindustries?

How do industries differ in risk-return patterns?

Do all firms in an industry perform in a similar

manner?


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Is the industry profitable?

What is the firms position in the

industry?


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Business cycle and Industry

Performance

Economic trend are expressed in the form ofcyclical changes and structural changes.


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What determines Industry

profitability

Short-term: Demand and supply

Long-term: Industry structure

Industry structure is determined byMichael Porters Five Forces


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Cyclical Changes

Arise from fluctuations in the business cycleresulting from fluctuations in interest rate,inflation, exchange rates, changes in GDP

Industry performance is related to the stage of thebusiness cycle.

No two cycles are exactly alike; therefore industryanalysis is not an exact science.


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Michael Porters Five Forces

1. Threat of New Entrants

2. Threat of substitute products

3. Bargaining power of buyers

4. Bargaining power of suppliers

5. Rivalry between firms


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The business cycle

QuickTime and a

decompressorare needed to s ee this picture.

Trough

PeakInterest sensitive stocks

Consumer staples

Capital goods,

Real Estate

Financial StocksConsumer durables,

commodities


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Business Cycle and Industry

Classification

Growth Industry - Sales through all phases

of Business Cycle

Cyclical Industry - Sales with Demand

Defensive Industry- Demand for product isindependent of Business

Cycle,


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External Factors affecting

Profitability

1. Technology

2. Government

3. Social Changes

4. Demographic Changes

5. Foreign Factors


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Sector Rotation

Selecting Industries in line with the stage of thebusiness cycle

Peaknatural resource firms

Contractiondefensive firms

Troughequipment, transportation andconstruction firms

Expandingcyclical industries

Economic activity oscillates with peaks and troughs


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Economic activity oscillates with peaks and troughsas a direct result of business and consumerexpenditures, inflation and interest rate fluctuations.

The stock market reacts differently at differentphases of the business cycle.

As the business cycle moves toward its peak withincreased economic activity, higher demand forgoods and services leads to price increases andinflation.


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Higher inflation prompts the Federal Reserve to tightenthe money supply increasing interest rates to controlinflation.

The rise in interest rates slows economic activitysometimes resulting in a recession.

Economic activity is measured by the GDP

Economic expansion and contraction is measured by

changes in the GDP.

A decline in the GDP for two or more consecutiveperiods constitutes a recession.

F t ff ti iti it f


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Factors affecting sensitivity of

earnings to business cycles

Sensitivity of sales of the firms product to the

business cycles

Operating leverage

Financial leverage


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Operating Leverage

A measure of how sensitive operating profit is to agiven percentage change in sales.

The extent to which fixed costs are part of acompany's cost structure

The higher the proportion of fixed costs the greaterthe sensitivity of net operating income to changes insales


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Financial Leverage

Total Debt divided by total Shareholders' Equity.

The extent to which debt is employed in the

company's capital structure.

How well the firm utilizes debt to increase ROE


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Industry performance and the

business cycle

Cyclical Industries

capital goods and consumer goods

see their stock price rise and fall with economic

activity

QuickTime and a decompressor

are needed to see this pi cture.

Trough

PeakInterest sensitive stocks

Consumer

staples

Capital goods,

Real Estate

Financial StocksConsumer durables,

commodities

Durable goods industries


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Durable goods industries

Auto, personal computer, appliances, smallequipment

Because the stock market looks ahead six monthsto a year, a perceived recovery bodes well for

durable goods.

Most consumers postpone the purchase of largeticket items during a recession and pent updemand makes those industries attractive toinvestors.


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Capital goods industries

Airplane industry, large machines and equipment

As the economy recovers and businesses begin to

notice an increase in sales, they begin to make capitalinvestments to expand product lines, run moreefficiently, keep costs down and increase capacity to

meet the expected increased demand.

Financial Industry


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Financial IndustryTo combat recessionary periods the Federal Reserve

expands the money supply to lower interest rates and

encourage consumer and business borrowing.

Investors perceive the recession is coming to an end

expecting bank incomes to rise as loan demandrecovers.

Therefore banks and financial company stocksbecome attractive investments and financial stockprices excel.

Basic Industries /commodities


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Basic Industries /commodities oil industry, gold, aluminum and lumber industries.

As the business cycle reaches its peak, prices rise intandem with increased demand for goods and services.

Companies that supply raw material to manufacturerssee increased demand

These industries are not adversely affected by higher

inflation because inflation has little affect on their costs

On the contrary they profit from increased demand andincrease in prices of the end product.

C t pl


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Consumer staples

Food, beverages and pharmaceutical industries

necessary products defensive industries

Exporters

Sales are affected by currency exchange rates

low interest rates usually trigger a weaker currency

which benefits exporters by making their productscheaper to over seas consumers.


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Other considerations

Construction industry does better in periods of lowinterest rates

High interest rates therefore help the do-ityourselfindustries

A weaker US dollar helps US exporters

Trade agreements help industries that faced quotasbefore.

Consumer sentiment as measured by the Consumerconfidence index comprises about 67% of the GDPand has a great impact on the business cycle.


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Structural Changes1. Demographics

2. Lifestyles

3. Technology

4. Politics and regulation

Arise from:

downsizing of corporate America,

changes in labor pool,

transitions from socialistic markets to capitalistic

markets as exemplified in eastern Europe in the 1990s.

1 D hi


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1. Demographics

has a large impact on type of products demanded

by consumers baby boomers and seniors - fasted growing age

group

trigger a shortage in entry level workers leading toincrease in labor costs

Changes in spending habits

population growth and age distribution Changing ethnic mix in society

Changes in income distribution.

2. Lifestyles


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y

Dual career families

suburban vs. urban living

Affect the housing industry, home entertainment,catalog shopping, convenience goods

3. Technology on-line shopping

bar-code scanning increases efficiency

Electronic data exchange

4. Politics and regulation


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Industry life cycle

Stage Sales Growth

Start-up ( pioneer) Rapid & Increasing

Growth Exceeds economic growthConsolidation Stable

Maturity Slowing

Relative Decline Minimal or Negative

***contributes to sales growth and profit estimates***

Start up stage


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Start up stage

Pioneering development

Small market for products Modest growth in sales

small to negative profits and profit margin

Rapid Accelerated Growth

Markets develop for the products

Rapid sales growth

Profit margin are high

Investors begin to notice

Mature growth - consolidation


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g

competitors enter the market place

Normalized profit margins

Stabilization and market maturity

Industry growth rate declined

Longest stage tight profit margins.

Deceleration and decline Substitutes and shifts in demand

Profit margins squeezed

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